Innovative Enterprise
William Lazonick
Center for Industrial Competitiveness
University of Massachusetts Lowell
National University of Ireland Galway
March 5, 2009
Innovative enterprise and economic performance
• Employees: Higher pay, better work conditions
• Creditors: More secure paper
• Shareholders: Higher dividends or share prices
• Government: Higher taxes
• The Firm: Stronger balance sheet
AND
• Consumers: Higher quality, lower cost products
Lazonick: UMass Lowell
By creating new sources of value (embodied in higher
quality, lower cost products), the innovative enterprise
makes it possible (but by no means inevitable) that,
simultaneously, all participants in the economy can gain:
Theories of resource allocation
Economics is about modes of resource allocation that
generate superior economic performance (that is,
“economic development”)
Social characteristics of a mode of resource allocation:
who makes allocation decisions?, what kind of
investments do they make? how are the returns from
those investments distributed?
The theory of the market economy: the conventional
perspective -- most critiques focus on state intervention to
correct for market imperfections and market failures
My argument: a viable economic theory needs to focus on
the roles of business enterprise and innovation in the
resource allocation process -- then bring in the role of the
(developmental) state
Lazonick: UMass Lowell
Think organizations, not markets
Market imperfections? (economic processes)
Assumes that “perfect markets” are an ideal mode of
economic organization – but market coordination does not
generate innovation, which entails a social process that is
uncertain, collective, and cumulative process
STOP THINKING “PERFECT MARKETS”, START
THINKING “INNOVATIVE ORGANIZATIONS”
Market failures? (economic outcomes)
Assumes an expectation that the market can generate
desirable economic outcomes – but undesirable outcomes –
e.g., an inequitable distribution of income – may reflect
ORGANIZATIONAL FAILURES
Lazonick: UMass Lowell
Economic approaches to
Innovation and Theories of the Firm
Economic Institutions
National Innovation Systems
Competitive Advantage of Nations
Sources of Industrial Leadership
Social Conditions of
Innovative Enterprise
Theory of the
Innovative Enterprise
Industrial Sectors
Business Enterprises
Five Forces Competitive Advantage Transaction-Cost Theory
Resource-Based Theory
Agency Theory
Disruptive Technology
Game Theory
Econ. of Industrial Innovation
Knowledge Creation
Theory of the Growth of the Firm
Evolutionary Theory
Dynamic Capabilities
Lazonick: UMass Lowell
The key questions
What is the relation of various approaches to
innovation and theories of the firm to the “social
conditions of innovative enterprise”?
I ask: What do each of these approaches have to
say about innovative strategy, organizational
learning, and investment finance? and b) what are
the implications for understanding the
performance of the enterprise of introducing the
concepts of strategic control, organizational
integration, and financial commitment – which I
will develop in this talk -- into the analysis?
Lazonick: UMass Lowell
What is a “firm” and what does it do?
“the firm”: transforms productive resources into goods
and services that can be sold to generate revenues
To transform productive resources into goods and services,
a firm engages in three generic activities:
• strategy: allocates resources to investments in human and
physical resources (who?)
• organization: develops the productive capabilities of these
resources (what?)
• finance: seeks to generate returns on the resources that it
has developed through sale of goods and services (how?)
Lazonick: UMass Lowell
What is an innovating firm?
Definition of “the innovating firm”:
given prevailing factor prices, the innovating firm
transforms the productive resources under its
control into higher quality, lower cost goods and
services than had previously been available at
prevailing factor prices
• thus defined, the innovating firm is an outcome of
a process that is
a) uncertain (cannot be done optimally)
b) collective (cannot be done alone)
c) cumulative (cannot be done all at once)
Lazonick: UMass Lowell
Theory and history
Lazonick: UMass Lowell
The theoretical challenge:
What are the characteristics of the business enterprise that
enable strategy to confront uncertainty, organization to
mobilize the collective process, and finance to sustain the
cumulative process that can result in innovation?
The historical challenge:
Constructing relevant theory from the comparativehistorical analysis of the role of innovative enterprise in
the economic development of regions and nations
Integration of theory and history:
At any point, theory serves as both a distillation of what
we know and a guide to discovering what we need to know
“Catching up with history”
• As economists, we want to be able to analyze
“history” as it unfolds around us
• We need to understand the social processes that
govern economic change
• We can only understand economic change by
analyzing the process as it has already occurred in
different times and places, i.e., a comparativehistorical approach
• But we do not want to be stuck in the historical
past
• We want to “catch up with history”
Lazonick: UMass Lowell
Back to basics
Starting point for constructing a theory of innovative
enterprise: textbook theory of the optimizing -- or “uninnovative” -- firm: Why un-innovative?
a) “Strategy”: all firms in an industry incur same fixed
costs of entry, given by exogenous industrial conditions
(technology and markets)
b) “Organization”: firm does not develop technology,
markets instantly absorb all that the firm wants to
produce -- but problem with addition of variable factors
c) “Finance”: implicitly assumes fixed costs can be funded
through capital markets – if product prices do not cover
variable costs, some firms quit the industry
Lazonick: UMass Lowell
Textbook theory of the optimizing firm
Lazonick: UMass Lowell
price,
cost
average
cost
marginal cost
p
c
marginal
and
average
revenue
q
c
output
Why is the cost curve U-shaped?:
with expansion of output, “control
loss” of adding more variable
inputs results in lower average
productivity of variable inputs,
which at some point offsets higher
average productivity of fixed
inputs through economies of scale
Is there an alternative to this
theory of the firm?
Technological and market conditions given by cost and revenue functions.
The “good manager” optimizes subject to technological and market constraints.
Transforming the theory of the optimizing firm into a
theory of the innovating firm…
Strategy: innovating firm makes high-fixed-cost
investments that differentiate it from other firms
Lazonick: UMass Lowell
From high fixed costs to low unit costs
Organization: a) innovating firm must develop the
capabilities of its investments, creating a problem of high
fixed costs; b) rise in unit costs resulting from “control loss”
NOT final outcome, but challenge to learn solutions
Finance: source of finance matters because returns are
uncertain : it takes time to develop productive resources
and gain access to markets – need “patient capital” so that
the firm does not have to drop out of the industry when
unit cost exceeds product price
Comparing optimizing and innovating firms
p = price; q = output; c = perfect competitor
pmin = minimum breakeven price; qmax = maximum breakeven output
price,
cost
How does the innovating firm transform
high fixed costs into low unit costs?
average
cost
marginal cost
p
Lazonick: UMass Lowell
c
innovating firm
marginal
and
average
pmin
revenue
c
q
c
output
optimizing firm
qmax c
output
Technological and market conditions are given by cost and revenue functions.
The “good manager” optimizes subject to technological and market constraints.
Through strategy, organization, & finance, innovating firm transforms technologies and markets to
generate higher quality, lower cost products. There is no “optimal” output or “optimal” price.
Shaping the innovative cost curve
Lazonick: UMass Lowell
price,
cost
actual
increasing
costs
innovating
firm
innovating firm:
phase 1
optimizing
firm
expected
decreasing
costs
output
Through innovative strategy , IE expects to
outcompete OF. But, in period one, IE’s
strategy only results in high unit costs, and
IE remains at a competitive disadvantage.
innovating
firm:phase 2
output
By internalizing variable factor creating
increasing costs, IE incurs even higher
fixed costs but the investment enables it
to “unbend” the U-shaped cost curve.
price,
cost
Invest
more, t1, to
overcome
increasing
costs
actual
increasing
costs, AC1
innovating firm, t1:
ACinnovator, p1 high fixed costs
+ increasing variable costs
= competitive disadvantage
MCoptimizer
pc
ACoptimizer
MR
Innovative
investment
strategy, t0:
“expected”
decreasing
costs
optimizing firm:
in textbook fashion,
equates MR and MC
to maximize profits
innovating firm, t2
even higher fixed costs
become lower unit costs
= competitive advantage
How, over time, can
innovation outcompete
optimization?
ACinnovator,AC2
qc
Lazonick: UMass Lowell
output
Strategy, organization and finance
in the theory of the innovating firm
price,
cost
innovating
firm: phase 1
Innovative strategy uncertain: continued
strategy, organization, & finance needed to
get the enterprise past phase one; remains at a
competitive disadvantage
Innovative strategy tends to be high-fixed
cost; need to develop interrelated set of
capabilities; extent of fixed costs depends on
size of investments and duration of time
between investments and returns
Innovative strategy only results in
low units costs if products can be
sold; otherwise they will not be
produced: need to bring product
market demand into the analysis
optimizing firm
innovating
firm:phase 2
output
Lazonick: UMass Lowell
Accessing market segments: product innovation
Lazonick: UMass Lowell
price,
cost
high income, price insensitive
Pr
od
uc
middle income, price matters
Supply curve t1
Phase 1: IF accesses
high- income segment
ti
nn
ov
at
io
low income, price sensitive
Supply curve t2
n
Phases 2 and 3:
IF accesses lower
income segments
Demand segments
output (units of quality)
What is the source of high income demand?
For example: integrated circuits - military; jet engines - military;
calculators - engineers; orphan drugs – national healthcare system
Accessing market segments: process innovation
Lazonick: UMass Lowell
price,
cost
high income, price insensitive
s
es
oc
Pr
Phases 2 and 3: IF
access higher
income segments
middle income, price matters
in
tio
va
no
low income, price sensitive
n
Supply curve t2
Phase 1: IF
accesses lowincome segment
Demand segments
Supply curve t1
output (units of quality)
Key to the indigenous innovation strategies of developing countries:
e.g., Japan from 1950s, Korea from 1980s, China from 1990s
Interdependent dynamics of supply and demand
The Innovating Firm promises to
share the gains of innovative
enterprise with employees to retain
and motivate them. When innovation
succeeds, “shared gains” are rewards
for unbending the cost curve (c1 to c2)
and increasing the extent of the
market (d1 to d2).
price,
cost
c1
p
1
d2
d1
2
Profits
c2
“shared gains”
ch = hypothetical cost structure
with wages unchanged from c1
q1
q2
output
For innovating firm, transformation of cost curve can reshape its demand curve
• “shared gains” with employees are integral to this productive transformation
• price-setting is integral to its competitive strategy
Lazonick: UMass Lowell
p
What do entrepreneurs do?
• Entrepreneurial strategy: innovation is inherently
uncertain
• Technological uncertainty
• Market uncertainty
• Competitive uncertainty
• It matters who the entrepreneurs are – what types of
people are able and willing to allocate resources to
innovative investment strategies?
• Overcoming uncertainty to generate innovation requires
finance and organization
• Why finance? You cannot do everything at once
• Why organization? You cannot do everything alone
Lazonick: UMass Lowell
Entrepreneurship and innovation
• That is, innovation is a cumulative and collective process
that confronts uncertainty
• Entrepreneurship is the allocation of resources to an
innovative investment strategy within a distinct unit of
strategic control, i.e., a firm
• The need for finance means that entrepreneurs may have
to share strategic control with financiers
• The need for organization means that entrepreneurs may
have to share strategic control with managers
• The entrepreneur initiates the innovation process, but the
more cumulative and collective that process, the more
likely that the role of “entrepreneurship” will disappear
Lazonick: UMass Lowell
Industries matter
Industries differ in terms of technological, market, and
competitive conditions – implications for developing and
utilizing productive resources
• technological conditions affect the requirements for
collective and cumulative learning – i.e., developing
productive resources
• market conditions affect the possibilities for
transforming high fixed costs into low units costs – i.e.,
utilizing productive resources
• competitive conditions determine the extent to which a
firm must develop and utilize productive resources in
order to be an innovative enterprise
Lazonick: UMass Lowell
Social conditions of innovative enterprise
Under what conditions do strategy, organization, and finance result
in innovation? Conceptualize the firm as a social organization
characterized by a set of “social conditions” that influence
the way that strategy, organization, and finance are done
Why “social”? Strategy, organization, and finance reflect relations
among people in the economy who occupy different hierarchical and
functional positions and have different abilities and incentives
Why focus on “the firm” as a social organization?
1) In the modern economy, the firm is the critical unit of control
over the allocation of resources to innovative strategies.
2) The modern firm employs lots of people (50 is a small enterprise
and 100,000 is not unusual), many of whom interact in collective
and cumulative learning processes that are central to innovation.
3) The modern firm cannot exist without substantial and sustained
funding; innovative strategy and organizational learning increase
the need for investment finance.
Lazonick: UMass Lowell
Strategy in the innovative enterprise
Strategic resource allocation confronts uncertainty:
™ Technological:
Can the firm develop superior processes and products?
™ Market:
Can the firm secure a large enough extent of the market?
™Competitive:
Will rivals generate higher quality/lower cost products?
Social Condition of Innovative Enterprise No. 1:
Who makes innovative strategy?
¾ abilities and incentives of those who exercise
strategic control in the firm
Lazonick: UMass Lowell
Organization in the innovative enterprise
Innovation requires organizational learning:
™ Collective learning: learning depends on the
interaction of people organized in a hierarchical and
functional division of labor
™ Cumulative learning: what can be learned today
depends on what was learned yesterday
Social Condition of Innovative Enterprise No. 2:
What innovative investments do they make?
¾ organizational integration of skill bases that can
generate collective and cumulative learning
Lazonick: UMass Lowell
Finance in the innovative enterprise
Transforming high fixed costs into low unit costs
™Fixed costs: determined by size & duration of
technological transformation
™Unit costs: depend on extent & timing of market access
™Control over revenues: keep innovative organization
intact while investing in the growth of the firm
Social Condition of Innovative Enterprise No. 3:
How are returns from investments distributed?
¾ sources of financial commitment that sustain
technological transformation and market access
Lazonick: UMass Lowell
Social conditions of innovative enterprise
• Strategic control: a set of relations that gives decisionmakers the power to allocate the firm’s resources to
confront uncertainty by transforming technologies and
markets to generate higher quality, lower cost products
• Organizational integration: a set of relations that create
incentives for people to apply their skills and efforts to
engage in collective learning
• Financial commitment: a set of relations that secure the
allocation of money to sustain the cumulative innovation
process until it generates financial returns
Lazonick: UMass Lowell
Strategic control
KEY QUESTIONS:
• Strategic control and asset ownership: How does
strategic control change with the growth of the firm?
Why might asset ownership be separated from
managerial control? Who is included in the structure of
strategic control?
• Strategic control, abilities: Who is able to allocate
resources to innovative investment strategies? What
role does experience in the firm and industry play?
• Strategic control, incentives: Do they want to allocate
resources to innovation? Why not just reap the returns
of past investments? How do their individual incentives
affect “organizational” goals?
Lazonick: UMass Lowell
Organizational integration
KEY QUESTIONS:
• Innovative skill bases, abilities: What hierarchical
responsibilities and functional specialties does the firm
seek to integrate into organizational learning processes?
What types of employees are “key”?
• Innovative skill bases, incentives: How does the firm
recruit/retain and motivate its “key” employees? How
does the structure of incentives reconcile individual
behavior with organizational goals?
• Innovative skill bases, change: What happens when
competitive challenges render innovative skill bases
obsolete ? How are collective/cumulative learning
trajectories transformed?
Lazonick: UMass Lowell
Financial commitment
KEY QUESTIONS:
• Internal funds: Are internal sources of funds important
for financing innovation? How does the firm ensure
that it can retain control over its revenues?
• Debt and the finance of innovation: Do bank loans
provide a source of financial commitment? In what
relation to internal funds? Do bond issues provide
financial commitment? Why loans or bonds?
• Equity and the finance of innovation: Does private
equity provide financial commitment, and to what types
of companies? What is the role of the stock market in
the finance of innovation?
Lazonick: UMass Lowell
Strategy and organization within the firm
Lazonick: UMass Lowell
Strategy and Learning
Innovative Skill Bases
Who allocates resources?
Are they integrated
with learning processes?
Functional
Technical Specialists
Skilled
“Semi” Skilled
Unskilled
Production
Workers
Hierarchical Integration?
Middle
Broad skill base:
functional
integration
How broad and deep are
the skill bases that the
learning process requires?
Top
Executives
Managers
Deep skill base:
hierarchical
integration
Integration?
Technical Specialists
Office
Workers
Skilled
“Semi” Skilled
Unskilled
Research agenda: how do innovative skill bases vary in breadth and depth across
nations, industries, and enterprises at a point in and over time?
Strategy and organization
within and across units of strategic control
Unit of Strategic Control
Inter-Company Relation
Proprietary Firm
Industrial District
New Venture
Vertical
Going Concern
Corporate
Enterprise
Divisions
Conglomerate
Interactions?
Spinoffs
Mergers and
Acquisitions
Buyouts
Enterprise Group
Horizontal
Subcontractor
Joint Venture
Strategic Alliance
Research Consortium
• Evolution of strategic control within a company? Impact on learning?
• Structure of strategic control across companies? Impact on strategy?
• Organizational integration across companies? Impact on learning?
• How do the sources of finance affect the structure of strategic control?
Lazonick: UMass Lowell
Evolution of
Company Structure
Cross-Company Structure of Control and Integration?
National institutions and business organizations
in the innovation process
Governance institutions and strategic control:
What are the rights and responsibilities that govern the allocation of
productive resources (labor and capital) in the economy? Where in
the economy is control over allocation decisions located? What are
the social processes that monitor, sanction, and reform such control?
Employment institutions and organizational integration:
To whom does society provide education, training, and access to
research? Through what organizations? For what purposes? Who
pays? How do people get jobs? With what expectations of rewards
over what time frame? Are careers within or across firms?
Investment institutions and financial commitment:
How are financial resources mobilized in the economy for
investments in productive resources? From what sources? On what
terms? With what expected returns?
Lazonick: UMass Lowell
Social conditions of innovative enterprise
Social Conditions of
Innovative Enterprise
Economic Institutions
Governance
Employment
Investment
reform
enable and proscribe
Strategic Control
Organizational Integration
Financial Commitment
embed
Industrial Sectors
Markets
Technologies
constrain
shape
Business Enterprises
Organization
Strategy
transform
Finance
Competition
challenge
Lazonick: UMass Lowell
Social institutions and innovative enterprise
Do governance, employment, and investment institutions
enable or proscribe innovative enterprise?:
• Need to understand the evolving relation between social
institutions and organizations in specific contexts
Do institutions that support innovative enterprise in one
era constrain it in another?
• Need to understand how, when, and whether, industrial
and organizational change drives institutional change
A research agenda:
• Comparative-historical study of capitalist development
with a view toward constructing a theory of innovative
enterprise that explores (not ignores) historical experience
Lazonick: UMass Lowell
Varieties of capitalism
in comparative-historical perspective
Marshallian industrial districts: craft foundations made Britain
“workshop of the world” in late 19th century
US managerial corporation: integrated management structures
made US dominant in first half of 20th century
Japanese challenge: power of broad and deep skill bases
US New Economy: power of highly educated skill bases
The rise of China and India: globalization of the labor force
Lazonick: UMass Lowell
European alternatives in second half of 20th century
France: functional integration for complex systems
Germany: hierarchical integration for high-quality goods
Italy: emergence of “neo-Marshallian” industrial districts
UK: organizational segmentation, not a viable alternative
Marshallian industrial districts
Strategic control:
• proprietary control (even with public shareholding (e.g.,
Oldham limiteds) by owner/managers with highly
specialized capabilities (restriction on firm growth)
Organizational integration:
• piece-rate payments; worker-run, on-the-job training for
highly specialized occupations; minimum of formal
education (learning regions, making entry easy)
Financial commitment:
• limited retentions (pressure for dividends when
available); living off invested capital; cyclical collective
bargaining (all of which constrained firm growth)
UK: 20th century legacy of Marshallian districts
Strategic control:
• persistence of proprietary control across British
industry; relative underdevelopment of managerial
organization; stock markets run for shareholders
Financial commitment:
• problem of shareholders who demand payouts rather
than leave funds in the firm to finance growth
Lazonick: UMass Lowell
Organizational integration:
• control over work organization left with workers, even in
new industries (autos, electronics) in which, until 1960s,
unions not a force; administrative & technical specialists
segmented from top management decision-making
Italian industrial districts
Lazonick: UMass Lowell
Strategic control:
• flexible specialization because of proprietary control
Organizational integration:
• vertically specialized and horizontally fragmented
structure of industrial organization: an alternative to
mass production
Financial commitment:
• role of regional financial institutions
Similar industries to British IDs: but they declined from
interwar period, and roots of decline much earlier
What makes Italian industrial districts different from
British (the original Marshallian) industrial districts?
Sustainability of Italian industrial districts?
Strategic control:
• far more entrepreneurship than British IDs; far more
collective services (training, administration, finance,
marketing), more diversified set of industries
Organizational integration:
• not necessarily sustainable in the face of innovative
competitors -- example of the Italian upholstered
furniture industries of Emilia-Romagna and MateraAltamura-Santeremo
Financial commitment:
• internal finance and the growth of the firm -- will
sufficient commitment be maintained to the funding of
collective services?
Lazonick: UMass Lowell
The “Marshallian” industrial district
Horizontal competition
O
r
V
g
e
a
r
n
t
i
i
z
c
a
a
t
l
i
o
n
...
...
...
...
...
sales
Global markets
design
assembly
components
Local resources
Skilled labor
Finance
Infrastructure
machines
Collective services?
Lazonick: UMass Lowell
Emergence of lead firms?
Horizontal competition
O
V r
e g
r a
t n
i i
c z
a a
l t
i
o
n
sales
Global markets
design
assembly
...
...
components
Local resources
Skilled labor
Finance
Infrastructure
machines
Global labor?
Collective services?
Lazonick: UMass Lowell
Legacy of the Marshallian industrial districts
Strategic control:
• persistence of proprietary control across British
industry; relative underdevelopment of managerial
organization; stock markets run for shareholders!
Organizational integration:
• control over work organization left with workers, even in
new industries (autos, electronics) in which, until 1960s,
unions not a force; administrative & technical specialists
segmented from top management decision-making
Financial commitment:
• problem of shareholders who demand payouts rather
than leave funds in the firm
Lazonick: UMass Lowell
The US Old Economy business model
Strategic control:
• separation of ownership and control secured by the rise
of liquid stock markets and widespread distribution of
shareholding; precondition for managerial control
Organizational integration:
• career rewards: distinction between salaried managers
and “hourly” workers; hierarchical specialization &
hierarchical segmentation; national educational system
important for managers, especially higher education
Financial commitment:
• retentions (after stable dividends), bonded debt, stock
issues relatively unimportant
Lazonick: UMass Lowell
US managerial control confronts UK craft control
Lazonick: UMass Lowell
United
States
Executives
=Hierarchical
Integration
Specialists
XXXXXXXXXXXXXXXXXXXXXXXXXXXX
“Semi-skilled” workers
=Functional
Segmentation
Britain
Executives
XXXXXXXXXX
Specialists
Craft Workers
and Assistants
XXX =Hierarchical
Segmentation
The Japanese challenge
Strategic control:
• secured by cross-shareholding; career managers exercise
control; the post-war rise of the “third-rank” executive
Organizational integration:
• lifetime employment: career rewards for all salaried
personnel, blue collar and white collar; hierarchical and
functional integration, notwithstanding hierarchical and
functional specialization (i.e., interactive learning); high
level of general education with in-house training
Financial commitment:
• main-bank system: retentions (with low dividends)
highly leveraged by state-supported bank finance
Lazonick: UMass Lowell
Organizational integration and international competition
United States and Japan, circa 1980
United
States
=Hierarchical
Integration
= Hierarchical
Interaction
Executives
?
?
Specialists ?
?
XXXXXXXXXXXXXXXXXXXXXXXXXXXX
“Hourly” Operatives
=Functional
Segmentation
Japan
Lazonick: UMass Lowell
Executives
Specialists
XXX =Hierarchical
Segmentation
Regular Male Operatives
XXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
Females/Temporary Employees
German and Japanese
business models compared
=Hierarchical
Germany
Integration
= Hierarchical
Interaction
Executives
Specialists
Craft Workers
Executives
Specialists
XXX = Hierarchical
Segmentation
Regular Male Operatives
XXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
Most females and temporary employees
Lazonick: UMass Lowell
Japan
= Functional
Segmentation
The French business model
France
PDG
XXXXXXXXX
Cadres
XXX =Hierarchical
Segmentation
X X X X X X X X
Techniciens
XXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
Ouvriers
Lazonick: UMass Lowell
Product
quality
Product
cost
High quality
Low cost
High cost
Japan
Germany
Italy France
Low quality
United States
(OE)
Britain
Adaptation and globalization in 1990s and 2000s
Lazonick: UMass Lowell
Institutions and
international competition: 1980s
The rise of the New Economy business model
Lazonick: UMass Lowell
Strategic control:
• control by managers secured by liquid capital markets;
may be owners but all strategic managers highly
specialized & experienced in particular industrial sector
Organizational integration:
• all salaried (not hourly), career rewards for motivation
plus stock-based compensation as recruitment/retention
tool; tap into global labor forces as highly educated labor
flows to capital, and capital flows to less educated labor
Financial commitment:
• venture capital reallocates money and people, funds
raised in IPO, retentions, little if any dividends and debt
Business model, old and new
OEBM
NEBM
Strategy,
product
growth by building on internal
capabilities; expansion into new
product markets based on related
technologies; geographic expansion to
access national product markets
new firm entry into specialized
markets; sell branded components to
system integrators; ac-cumulate new
capabilities by acquiring young
technology firms
Strategy,
process
development and patenting of
proprietary technologies; vertical
integration of the value chain, at home
and abroad
cross-license technology based on
industry standards; vertical
specialization of value chain;
outsourcing/offshoring routine work
Finance
venture finance from personal
savings, family, and business
associates; NYSE listing; pay steady
dividends; growth finance from
retentions leveraged with bond issues
organized venture capital; IPO on
NASDAQ; low or no dividends;
finance from retentions plus stock as
an acquisition currency; stock
repurchases to support stock price
Organization
secure employment: “organization
man” (career with one company);
industrial unions; DB pension;
employer-funded medical insurance in
employment and retirement
insecure employment: interfirm
mobility of labor; broad-based stock
options; non-union; DC pension;
employee bears greater burden of
medical insurance
Lazonick: UMass Lowell
The US New Economy business model
US-Based Operations
Global Operations
Executives
O
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Global markets
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design
Specialists
Global labor
Contract manufacturers
Component producers
Global labor
Machinery makers
Venture capital
Lazonick: UMass Lowell
Business enterprise and economic development
• Economic development: not just “states” and “markets”
• Role of states: invest in uncertain technologies, access
global markets for national firms, limit competition in
domestic markets, subsidize innovative enterprise
• State interventions to support innovative enterprise
cannot be construed as “market failures”
• Power of firms to control the flow or capital and labor,
and to have privileged access to product markets cannot
be construed as “market imperfections”
• Need a theory of innovative enterprise that can
comprehend cross-national institutional conditions to
explain international competition advantage Lazonick: UMass Lowell
Why has neoclassical economics
ignored the analysis of innovative enterprise?
• Illusion that of a world of “perfect” markets as yielding
“optimal” economic performance, and hence the
analytical focus on market imperfections and market
failures
• Ideology that no actor exercises power over others in a
“market economy”
• Firms as passive actors in the economy that respond to
the dictates of technology and markets (summation of the
given utility functions of individuals)
• Economists trained to find equilibrium conditions
(constrained optimization), and avoid the analysis of
change (historical transformation)
Lazonick: UMass Lowell
The illusion of analyzing reality
Economists have appeared to recognize reality of
large-scale enterprise in monopoly theory :
• departure from the perfectly competitive ideal
• restrict output, raise prices
• theoretical foundation of 20th century anti-trust
policy
•but theory of monopoly is fundamentally flawed
Lazonick: UMass Lowell
Schumpeter on the “Monopoly Model”
“What we have got to accept is that [the large-scale
enterprise] has come to be the most powerful
engine of [economic] progress and in particular of
the long-run expansion of total output not only in
spite of, but to a considerable extent through, the
strategy that looks so restrictive when viewed in the
individual case and from the individual point in
time. In this respect, perfect competition is not
only impossible but inferior, and has no title to
being set up as a model of ideal efficiency.”
Joseph A. Schumpeter, Capitalism, Socialism, and
Democracy, p. 106.
Lazonick: UMass Lowell
p = price; q = output
m = monopolist; c = perfectly competitor
pmin = minimum breakeven price
qmax = maximum breakeven output
average
revenue marginal
marginal
revenue
p
p
cost
2
average
cost
By transforming high fixed costs into low unit
costs, IF can achieve lower costs and higher
output than PCs that optimize subject to
constraints. The low-cost, high-output IF
becomes a “monopolist”!
innovating firm (IF)
m
c
perfect
competitors
(PCs)
pmin c
q m qc
1
Monopoly means lower output and
higher prices = inferior performance.
But how did the monopolist gain a
dominant market position?
qmax c
3
THE LOGICAL FLAW: It is invalid to assume
that the cost structures of “competitive” firms
would be the same as those of enterprises that
are dominant in an industry.
Lazonick: UMass Lowell
The flaw in the monopoly model
Marshall on the “Monopoly Model”
The “Monopoly Model” emerged out of post-Marshallian
economics. But Marshall himself recognized the flaw.
Alfred Marshall, Principles of Economics, Ninth edition, Macmillan,
1961, 484-485.
WHAT THE MODEL ARGUES:
“The monopolist would lose all his monopoly revenue if he produced
for sale an amount so great that its supply, as here defined, was
equal to its demand price: the amount which gives the maximum
monopoly revenue is always considerably less than that. It may
therefore appear as though the amount produced under a monopoly
is always less and its price to the consumer always higher than if
there were no monopoly. But this is not the case.”
Lazonick: UMass Lowell
Marshall on monopoly, continued
WHY THE MODEL IS FLAWED:
“For when the production is all in the hands of one person or
company, the total expenses involved are generally less than would
have to be incurred if the same aggregate production were
distributed among a multitude of comparatively small rival
producers. They would have to struggle with one another for the
attention of the consumers, and would necessarily spend in the
aggregate a great deal more on advertising in all its various forms
than a single firm would; and they would be less able to avail
themselves of the many various economies which result from
production on a large scale. In particular they could not afford to
spend as much on improving methods of production and the
machinery used in it, as a single large firm which knew that it was
certain itself to reap the whole benefit of any advance it made.”
Lazonick: UMass Lowell
Marshall on monopoly, continued
MONOPOLY AUGMENTS OUTPUT, REDUCES PRICE:
“This argument does indeed assume the single firm to be managed
with ability and enterprise, and to have an unlimited command of
capital – an assumption which cannot always be fairly made. But
where it can be made, we may generally conclude that the supply
schedule for the commodity, if not monopolized, would show higher
supply prices than those of our monopoly supply schedule; and
therefore the equilibrium amount of the commodity produced under
free competition would be less than that for which the demand price
is equal to the monopoly supply price.”
Marshall adds in a footnote (485n):
“Something has already been said (IV, XI, XII; and V, XI), as to the advantages
which a single powerful firm has over its smaller rivals in those industries in which
the law of increasing return acts strongly; and as to the chance which it might
have of obtaining a practical monopoly of its own branch of production, if it were
managed for many generations together by people whose genius, enterprise and
energy equalled those of the original founders of the business.”
Lazonick: UMass Lowell
Lessons for the poorer economies
Important lessons?
For one, the theory of innovative enterprise provides a
rationale for infant industry protection; but the infant
industry argument lacks substance if it is a) just based on
state policy, and b) does not explain how indigenous
innovation results in competitive advantage even as it
raises the incomes of participants in the process
Lazonick: UMass Lowell
My ultimate goal: not to understand changing business
models but rather the process of economic development;
have to understand the role of business organization in the
development of the advanced economies to understand the
problems and possibilities of that the less advanced
economies face
price,
cost
Like the theory of innovative enterprise, the infant industry
argument depends on the transformation of competitive
disadvantage into competitive advantage
average
cost
marginal cost
p
c
innovative enterprise in
a once-poor economy
(a grown-up infant)
marginal
and
average
pmin
revenue
c
q
c
output
Lazonick: UMass Lowell
Theory of innovative enterprise
and the infant industry argument
established
firm, advanced
economy
qmax c
Technological and market conditions given by cost and revenue functions. Theory
says that poor nation should compete in industries in which it has comparative advantage.
Innovative enterprise can transform technologies and markets to generate higher quality, lower cost
products. Protection that supports innovation can enable poor nation to gain competitive advantage.
Indigenous innovation and economic development
“Indigenous innovation” can occur when national
institutions support business enterprises in confronting
technological, market, and competitive uncertainty and
engaging in collective and cumulative learning
Well-developed product, labor, and capital markets are
outcomes of the innovation process
Indeed to generate innovation, the business enterprise uses
strategy, organization, and finance to exercise control over
product, labor, and capital markets
Lazonick: UMass Lowell
Indigenous innovation and economic development
Social characteristics of a mode of resource allocation:
who makes allocation decisions?
what kind of investments do they make?
how are the returns from those investments distributed?
Specifics of “who, what and how” of innovative enterprise
will differ across industries over time, and in different
institutional environments -- but social conditions of
innovative enterprise are general principles that are
central to the study of economic development
Lazonick: UMass Lowell